Inequality matters. It is often thought that only absolute poverty is important and that if all members of society have a minimum standard of living, the relative distribution of wealth is of no consequence. However, inequalities in income, wealth and opportunity have been found to lead to political instability; provide incentives for crime; create barriers to entry in labour markets; discourage productive work; prevent engagement in entrepreneurial and educational opportunities; exacerbate socio-economic; ethnic and racial prejudices, and dampen economic growth.
When the differences between rich and poor are large, there is a need to protect one’s assets against those seeking to earn income by appropriating those assets by criminal means. Because of the barriers to education, credit and socio-economic upliftment in unequal societies, the opportunities for income-generation through crime are more attractive.
The positive causal effect of education on growth has been tested many times by several academic disciplines and is generally accepted. However, the effect of inequality on education, and thus growth, is less obvious. In East Asia, government policies, designed to ensure the sharing of the benefits of economic growth, led to mass education and health programmes and have been key to the phenomenal success of the East Asian economies since the 1960s. A virtuous cycle was created where education contributes to economic growth, which stimulates investment and then, in turn, fosters an environment in which people seek education and training.
Highly unequal societies tend to have a wider range of quality in schooling. This serves to entrench social inequalities and racial and ethnic prejudices, and can have negative psychological impacts that lead to discouragement and shirking at school and at work.
It has been suggested that the work ethic in Asia might be less due to cultural norms than a positive response to incentives. A society in which many people perceive barriers to entry into education, credit and formal or informal labour markets, will provide fewer incentives for productive effort.
A link has been found between low levels of inequality, high savings rates and high rates of return for private investment in the fast-growing East Asian economies. This contradicts the belief that the concentration of income in the hands of a few is necessary to ensure high rates of savings and investment because the rich are more likely to make wise investment decisions.
South Africa ranks among the most unequal societies in the world. A common measure of income inequality used is the Gini coefficient, which ranges between zero and one (or when multiplied by 100, between zero and 100). The closer it is to a 100, the more unequal a society. Gini coefficients around 30 reflect fairly equal societies, while those above 55 are considered relatively unequal. South Africa has a coefficient of 65. The World Gini coefficient is currently at 66 points and is considered by the United Nations Development Programme to be “grotesque”.
A selection of Income Gini coefficients for the developed world, Asia, Latin America and Africa shows that income inequality is the lowest in the developed world, with an average of 33. Asia is next with a group average of 42. Latin America and Africa have the most unequal income distributions; they both have group averages of 56. In Africa, Zimbabwe, Burkina Faso, Zambia, Lesotho and South Africa are the most unequal countries, with Gini coefficients over 60. Similar distributions are found in the Latin American economies of Bolivia, Brazil, Chile and Nicaragua. Among the developed economies and those in Asia, there are none above 55.
Data for 93 countries from between 1970 and 2004, including 22 countries from sub-Saharan Africa, 18 from Latin America, 13 from Asia and 22 developed countries, show a negative relationship between inequality and growth. Specifically, a 10 percentage point decrease in the Income Gini coefficient, or improvement in inequality, is found to lead to a 1,2% increase in the per capita gross domestic product (GDP). Given that even small point increases in GDP are celebrated, an increase of more than 1% is astounding. Furthermore, a 10% increase in the literacy rate was found to increase GDP growth only by 0,3%, highlighting the importance on inequality reduction to the same extent that we focus on, say, education policy.
Given that the income distribution in South Africa is among the most unequal in the world, economic growth has lagged behind that of other comparable developing economies and, because a reduction in the Gini coefficient can be shown to improve economic growth, income inequality deserves the government’s urgent attention. Since the earliest economic plans of the new government, growth of at least 6% has been considered necessary to reduce poverty and unemployment.
In the 10 years since democracy, this has never been achieved. Given current government projections of GDP growth of 4,8% by 2008, the positive impact lower inequality can have on economic growth might go some of the way to achieving the desired growth target. A 10-point decrease in the Income Gini coefficient would increase GDP per capita growth to an annual average of 3,5%, from the current 2,3%, and overall GDP growth to an annual average of 5%, from the current 3,7%.
Rejane Woodroffe is an economist at Metropolitan Asset Managers